SIM: Indian outsourcing companies get a new competitor

February 8, 2010 — INDOLINK Consulting (es)

MUMBAI: In 2004, at the height of the American presidential campaign dominated among other things by offshoring and a jobless recovery, HCL’s Vineet Nayar set off a firestorm with a comment that American graduates were not employable.

As trade unions seethed and politicians fumed, two men looked at the reaction the comments had caused and wondered if there was a business opportunity.

Since offshoring was considered a purely Indian phenomenon and sensing a backlash to the process in the years ahead, Debashish Sinha and Neeraj Gupta two IT industry executives in the US began quietly working on an alternative that would appeal to many companies and the political establishment.

It took them five years to come up with a concrete plan and get investor funding. System In Motion (SIM), a Michigan-based start up, launched few months ago plans to challenge the traditional offshore outsourcing market leaders by delivering low cost services from locations such as Ann Arbor.

With the Indian outsourcing industry still being viewed by some in the US as one of the reasons for the country’s ‘jobless recovery’, this start up is promising to create more than 1,100 jobs over next five years in Michigan, home to Ford, General Motors and Chrysler-the Detroit’s big three.

“With nearly 30% unemployment rate in the region, for every Java programmer advertisement we put, there are around 100 applicants, with many of them having a decade’s experience,” says Sinha. The company is backed by several angel investors including Preetish Nijhawan, the Akamai founder, has Michael G Parks, the former CIO of Virgin Mobile and Wells Fargo on the board too.

“I would agree that there will be more start-ups providing onshore services but it will remain a niche business and represents the ongoing evolution of outsourcing rather than indictment against offshore outsourcing. The bulk of new jobs in the US have long been created by small businesses and this is another example of that,” said Stan Lepeak, managing director of Equa Terra’s global research pravctice.

The Michigan government has already assured tax rebates worth around $7.4 million linked to the job creation. In her ‘state of the state address’ delivered last week, Michigan governor Jennifer M. Granholm praised System In Motion for creating some 1,900 jobs in the Pittsfield township.

Local outsourcing to low cost American locations is not entirely a new trend. Smaller US firms such as Rural America Onshore Sourcing and Xpanxion have been attempting to build a sustainable rural outsourcing model in the US at a time when offshore locations such as India are facing a backlash and unemployment rates have touched an all-time high.

Xpanxion, an Atlanta-headquartered software firm, which shifted its software testing work from Pune to Nebraska a few years ago is among a handful of such firms seeking to create a more comfortable and cost-effective alternative to offshore outsourcing.

NCR, Coca Cola and Goldleaf Financial Solutions are among customers outsourcing software projects to Xpanxion. Cost advantages of delivering a project from a location such as Corsicana, or Kearney (Nebraska) could be almost 20-40% cheaper when compared to Los Angeles.

“In some ways Vineet’s comments (and the local reaction) were among trigger. The market also is beginning to see offshoring as a pure INdian phenomenon, but we launched System In Motion to leverage the American workforce,” says Sinha.

Nayar clarified on his comments in his blog posting, and said that employability crisis was a global problem that needed to be solved together by schools, governments and the students.

With the highest unemployment rate in the US, the state of Michigan not only offers an available pool of experienced software development professionals at 20-30% lower salary levels than California or Boston, it is also home to some top outsourcing customers who want to stave off rising anti-offshoring sentiment by participating in local job creation.

SIM has only seven customers so far and they include some top automakers and Thomson Reuters. At this stage, the firm is far away from being any substantial threat to India’s $50-billion offshore outsourcing industry. However, amid high unemployment rates in the US and local anti-offshoring sentiments the company looks set to become a trendsetter.

“I have seen that offshoring requires tremendous energy and efforts and some projects can’t sustain the overheads,” argues Parks, who is chief delivery officer of SIM, has dealt with top outsourcing companies including TCS and Wipro during past assignments.

“There are 7-8 Fortune companies including Ford, GM and Chrysler, almost 3,12,000 students are available within 75 miles and the unemployment rate is nearly 30%. If you add the local incentives and Michigan becomes a globally competitive location,” says Gupta, an IIM-Calcutta and BITS Pilani graduate. Gupta, who headed Patni Computers’ global sales and marketing until last year, is the chief executive of SIM.

SIM is hoping that potential outsourcers with less than $2 billion in revenues and with around $7-8 million outsourcing budgets may instead want to keep the jobs within US.

“Offshore outsourcing industry has struggled to address the needs of mid market where there is no scale,” he says. This, according to him, is where the sweet spot lies for System In Motion. When Gupta and Sinha met in February last year for discussing the start up, the recession was worsening and their own employers were preparing to hire more locals in order to address political sentiments.

“The entire mechanics of the global delivery model and investor expectations is based on an India-led model, and it would be too much to expect these organisations to change dramatically,” argues Gupta. He added that customers were struggling to manage global risks and also address the local employment issues at that time.

“We were seeing wage inflation in India, and around 20% wage inflation in the US,” says Gupta. For some of the top Indian tech firms, hiring local workers in the US had indeed picked momentum. “What these companies are doing is developing the top end of the pyramid, they will never spend time on developing the bottom, they cannot have their entire pyramid in the US,” says Sinha.

Meanwhile, the economics of offshoring still outweigh the benefits of delivering projects locally, as Indian engineers get paid nearly a third of what their US counterparts make.

While there is no official estimate about the size of market for project delivered from low cost locations in the US, Gupta is hoping that at least 20% of over $200 billion US IT services market could be addressed with this model.

Local experts such as Stan Lepeak, managing director of Equa Terra’s Global research practice say that despite initial momentum, SIM would continue to be a niche firm.

“I would agree that there will be more start-ups providing onshore services but it will remain a niche business and represents the ongoing evolution of outsourcing rather than indictment against offshore outsourcing,” he said.

“The bulk of new jobs in the US have long been created by small businesses and this is another example of that,” Mr Lepeak added. Executives at bigger outsourcing rivals question the ability of SIM to sustain some of the competitive advantages.

“What happens when the economy rebounds, all those available to work at lower wages will go back to high paying jobs,” said a senior official at one of the large Indian tech firms.

Rodney Nelsestuen, senior research director at outsourcing advisory firm TowerGroup agrees. “I lived in Michigan for 12 years and the mentality is not around low paying jobs since Michigan has had high paying jobs for 100 years. It will take a number of years to change that,” said Mr Nelsestuen.

“Tax breaks will stimulate some new business but there needs to be commercial credit which is still tight and a business case for success which is far from certain,” he added.

For large outsourcing customers, India would continue to remain attractive. “While trends relative to protectionism, tax laws, exchange rates and unemployment levels have benefited onshoring, skilled labor shortages and the superior cost savings that offshore work brings still have a much greater impact on buyer’s sourcing patterns,” Mr Lepeak said.